The January seasonal trade has begun. Here's how you can master it.

MW The January seasonal trade has begun. Here's how you can master it.

By Lawrence G. McMillan

The S&P 500 typically gains over the next few trading days

The January seasonal trade is usually one of the year's best seasonal trades (right behind the October seasonal). The trade is to buy the S&P 500 SPX at the close of the 18th trading day of the year and exit at the close of trading four days later. Typically, large fund managers will put money to work at the beginning of the year (hence, the positive seasonality of the January early warning system) and then complete their buying at the end of the month.

Since 1986, this trade has delivered 31 wins against eight losses. On average, SPX advances 1.1% in that four-day period.

This year, the 18th trading day was Wednesday, Jan. 29, but you can still participate. This trade captures the trend: Buy 2 SPY SPY (Feb. 14) at-the-money calls. Roll the calls if they become 8 points in-the-money. Exit the trade at the close of trading on Tuesday, Feb. 4.

Earnings season

Several large-cap tech stocks are reporting earnings this week and next. We took a look at how their options are pricing in advance of the earnings. There's been some speculation that the options are underpricing the potential for post-earnings movements. This theory has been heightened by the recent action in Netflix $(NFLX)$. The at-the-money nearest-term straddle on NFLX, just prior to last week's earnings, was priced at 73.25 (or 8.4% of the stock price). The day after the earnings, NFLX rose 130 points intraday and closed 85 points higher.

That certainly justified the purchase of the straddle for 73.25. But the real question is, how did that earnings move compare with Netflix's previous post-earnings moves? It turns out that of the previous nine earnings reports, three were greater than 8.4%, three were about in line with 8.4%, and three were much smaller. So, paying 8.4% for the straddle didn't look so great when looking at the past earnings movements. But proponents of buying straddles this quarter say that these stocks are going to exceed their historic movements after earnings.

Several other highflying stocks are due to report soon. Here they are, along with the recent price of the near-term straddle: Apple $(AAPL)$, 4.6%; Amazon.com $(AMZN)$, 7.8%; Chipotle Mexican Grill $(CMG)$,7.6%; Expedia Group (EXPE), 10.0%; and Qualcomm $(QCOM)$, 7.9%. Only Amazon and Expedia seem feasible when looking at previous post-earnings movements. The current straddle price is lower than about half of those previous movements, but even that only gives you a 50/50 chance.

So, the theory that these option straddles are underpriced for this quarter's earnings seems to be incorrect. Yes, it worked for Netflix, but it seems to be marginal for the stocks listed above.

S&P 500 breaks out - or did it?

The S&P 500 hitting new all-time highs but not being able to hold them provides investors with two pieces of important insight. First, there's now greater resistance near 6,100, and second, there's a possibility that the upside breakout was a false signal.

When SPX fell from those highs, it gapped downward - creating another "island" reversal on its chart. This one is a negative pattern. Previously, there had been a bullish island reversal at the beginning of November. Both are circled on the SPX chart below. In essence, SPX is in a volatile trading range between support at 5,760-5,870 up to resistance at 6,100.

The most recent traversal of that trading range, in mid-January, left several gaps on the chart. The lowest one has not yet been filled. Most gaps on a broad-based chart such as SPX are eventually filled. That one extends down to 5,860, the top of the support zone.

Equity-only put-call ratios are somewhat inclusive at the moment. They moved higher beginning in mid-December, and that is bearish for stocks. Recently, they have curled over a bit, and it would appear that they are rolling over to buy signals. However, the computer programs that we use to analyze these charts have been insisting that these ratios are going to begin moving higher again, and thus they remain on sell signals.

The "hard" definition of a signal is that a peak or trough lasts for 10 trading days. The recent peaks on these charts occurred seven trading days ago. If those peaks persist for another three trading days, computer analysis becomes irrelevant at that point, and buy signals are declared.

Market breadth has weakened over the past four trading days, and the breadth oscillators are on the brink of relinquishing their recent buy signals and rolling over to sell signals. Any change of signal from this indicator requires a two-day confirmation, so there is still time for them to avoid the sell signal, but again, the next few days are important here.

New highs on the New York Stock Exchange have had no trouble outnumbering new lows, and so this indicator remains bullish. New lows would have to be greater than new highs for two consecutive days in order to cancel out this buy signal.

Realized volatility - as measured by the 20-day historical volatility of SPX (HV20) - has pulled back some. It is currently at 15%. If it falls back below 13%, that would terminate this sell signal, for realized volatility would no longer be in an uptrend in that case.

Implied volatility VIX has dropped substantially in recent days and is now almost exactly at its 200-day moving average. There has been another "spike peak" buy signal, as denoted by the green "B" on the accompanying VIX chart. In fact, there have been many "spike peak" buy signals since early August. Most of these have been successful. We are still carrying a position from the mid-December buy signal, and now we are rolling it over because of this new buy signal. This signal would be stopped out if VIX were to close above its most recent peak, at 22.51. There is not a trend of VIX signal in place at this time.

The construct of volatility derivatives is bullish in its outlook for stocks now. When the market sold off earlier this week, the term structures flattened only a little, and now they are sloping upwards again. That is a positive sign for the stock market.

A strongly bullish seasonal pattern is now underway, lasting from the close of trading on the 18th trading day of January (Jan. 29 this year) and continuing for the next four trading days. Perhaps that will be enough to move the equity-only put-call ratios and the breadth oscillators to a more positive reading as well.

We are not carrying a "core" position because SPX is within its volatile trading range. We will trade new signals as they occur, and we will continue to roll deeply in-the-money options to lock in partial profits.

New recommendation: Fidelity National Information Services $(FIS)$

A new put-call ratio buy signal has been registered here, so we are going to act on it. Buy 2 FIS (FIS) (Apr. 17) 80 calls in line with the market. We will continue to hold these calls until the weighted put-call ratio of FIS rolls over to a sell signal.

Follow-up action:

All stops are mental closing stops unless otherwise noted.

We are using a standard rolling procedure for our SPY spreads: In any vertical bull or bear spread, if the underlying hits the short strike, then roll the entire spread. That would be roll up in the case of a call bull spread or roll down in the case of a bear put spread. Stay in the same expiration and keep the distance between the strikes the same unless otherwise instructed.

Also, for outright long options, roll if they become 8 points in-the-money.

Long 4 WBA (Feb. 21) 12.5 calls: This is the "alternative" Dogs of the Dow position. Just when it looked like Walgreens $(WBA)$ was about to advance after a positive earnings report, the U.S. Justice Department has threatened legal action on another front. Hold without a stop at this time.

Long 1 SPY SPY (Feb. 7) 606 call: This position was originally based on the latest "spike peak" buy signal of Dec. 19. It was subsequently rolled to this call. A new "spike peak" buy signal has occurred, so we are going to sell this call and replace it with the following spread: Buy 1 SPY (March 7) at-the-money call and Sell 1 SPY (March 7) call with a striking price 20 points higher.

Long 1 SPY (Feb. 21) 580 put and short 1 SPY (Feb. 21) 550 put: This spread is to be held as long as at least two of these three indicators remain on sell signals: HV20, trend of VIX, and equity-only put-call ratios. The trend of VIX sell signal has been stopped out, but the other two are still in place for now.

Long 1 AMZN (Feb. 21) 215 put: Sell this put now, since the put-call ratio has rolled over to a buy signal.

Long 1 SPY (Feb. 7) 605 call and Short 1 SPY (Feb. 7) 618 call: This position was bought because of the breadth oscillator buy signals. If both roll back over to sell signals, then we will exit the position.

Long 1 QQQ QQQ (Feb. 7) at-the-money put: This was bought in line with the seasonal "January defect" trade. Per previous instructions, the put should have been sold at the close of trading on Jan. 29.

Long 1 SPY (March 7) 607 call and short 1 SPY (March 7) 622 call: This position is based the NYSE "new highs vs. new lows" buy signal. This trade would be stopped out if, on the NYSE, new lows were to outnumber new highs for two consecutive days.

Long 1 SPY (March 21) 607 call and Long 1 SPY (March 21) 595 put: We bought the March 607 straddle last week, with instructions to roll either option if it became at least 8 points in-the-money. On Jan. 27, SPY gapped lower and opened at 595, so the put was rolled down at that time. Continue to roll any option that becomes at least 8 points in the money.

All stops are mental closing stops unless otherwise noted.

Send questions to: lmcmillan@optionstrategist.com.

(MORE TO FOLLOW) Dow Jones Newswires

January 30, 2025 15:25 ET (20:25 GMT)

Copyright (c) 2025 Dow Jones & Company, Inc.